Candle sticks, they are the first things we look at when we start our technical analysis, they are the basic unit for reading what's going on in the market and are very important— I read a whole book about them. After reading and actually being able to apply my refined and personalised knowledge of candlesticks to becoming a profitable trader, I realized something very funny — I didn't use most of the complicated stuff I read about candlesticks in my daily trading and most of the important stuff about candlesticks in real trading are the basics.
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| Stop trying to memorize candlestick patterns |
I look around the internet and notice candlesticks are largely overcomplicated by text books and teachers. And while they are very important for technical analysis, the most useful aspects of candlesticks are often the most basic aspects about them and the most "not so important" aspects about them are usually used less and less by the experienced and profitable traders.
There's an obsession on the internet with spotting Candlestick patterns, people forget the pattern doesn't matter, it's what price is doing at the moment that matters.
I'm going to teach you how to actually use candlesticks in your trading and not just identify what hammers look like.
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| A pattern can show up anywhere for whatever reason, it won't always mean something |
When I started my trading journey I was clueless about candlesticks so like any other normal guy— I read a book about candlestick charting called "Japanese candlesticks" — it drew me in, I was in love with the Japanese origins of all the terms, I was obsessed with spotting hammers, the shooting stars, the engulfing patterns and everything, it taught me most of what I use for my trading now, I still recommend that book as a beginner great technical analysis fundamentals book and often go back to it. Check out my review of the 5 books that can help you become a profitable trader.
But then I actually started traded— I immediately came to a humbling realization, it was that technical signals are not prophecies — they are just signals. I learnt that understanding what went on in the chart at any moment through being able to interpret properly the candle sticks is what's more important. Understanding what price is doing at any moment is the real strength of candle stick charting, not knowing what hammers look like. Candle sticks are meant to be a visual language for interpreting the chart.
So what are candlesticks? Well, they are the basic building blocks of the modern price chart, they are called so because they look like candlesticks. They were designed to be a simple way to represent all the important price points of a period.
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| Positive/Bullish Candlestick |
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| Negative/Bearish candlestick |
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A move in price on daily timeframe, each candle represents a day |
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Same move in price but in 4 hours timeframe will show more details |
There are two main parts of a candlestick.
The real body
This is price summary of the starting and ending prices for that time period. A big body represents a large change in change in whatever direction the color of the body is ( up, or down) , small real bodies represent small changes in price at the end of that time period, it doesn't matter how long the wicks are around the small body, the body is the end result after that period.
Wicks
These represent price extremes that were not maintained at the end of the candle stick period. They are where price has been rejected from within that candlestick period and can be very important in analysis. A big wick compared to the size of the body could be a sign of major price rejection at the zone of the wick and could be a sign of buying or selling power at that zone to reverse price.
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| Rejection wick on higher time frame |
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| Same rejection but in a smaller time frame |
Wicks can also indicate what direction the current force of the market is, a bunch of candles with wicks pointing opposite the direction of their bodies could be a sign of a rejected price reversal, showing the strength of the current trend.
Several wicks rejecting price drop on higher timeframe
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| Same zone on lower time frame |
But make no mistake, the body of the candlesticks is what matters the most when analyzing charts, what price started and end at is what is "Real" and what can be counted on is what I say.
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| Candle stick real bodies forming a price level |
I rely so much more on the real body size than the wicks for analysis—I've made extra efforts to reduce the opacity of the wicks on my charts so I can take note of the position and size of the candlestick bodies in my charts.
The two most important uses of candlesticks:
Candlesticks are used primarily by traders as indicators of the strength and momentum of a price move and as indicators of a decline or a reversal of a current price movement.
Price momentum indicator
A strong move in price will often be exposed by an increase in the size of consecutive candle real bodies. A strong trend will usually have a large candlestick followed by even larger candlesticks or just as large candlesticks and often when the momentum of a move is declining you will notice appearance of smaller body candle sticks until a small body candle stick (called a Doji) is formed.
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| Aggressive and less aggressive price moves all end with doji |
A Doji candlestick is usually a very good indicator of a slow down in momentum that could be followed by a reversal in price movement.
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| Candle sticks body size showing change in price momentum |
Candle sticks and price reversal
I mentioned earlier that a Doji at the end of a weakening price move can be a good sign of price direction change but long candlestick wicks can also be a great indicator of price rejection at certain zones, especially when they are on candlesticks with small bodies. Having a long wick represent price rejection and then the small body representing a loss in momentum are two telling signs of price reversal.
Let me introduce you to two very interesting candlesticks — the hammer and the shooting stars.
As you can see in the illustrations, they are basically the same candlesticks reversed, the color of the bodies don't matter as long as they have small bodies.
They consist of a small real body with a very long wick indicating price rejection a the end of a price movement, as a result hammers and shooting stars serve as a sort of double tell that price could be ready to reverse— as the have a small body indicating loss of momentum in price and the long wick shows a sharp rejection. The shape and form of hammers don't matter as much as when they show up, hammers mean more when they show up at points price have reversed at in the past (resistance and support zones).
A hammer and shooting star forming levels and a hammer being disrespected
Candle stick combinations
I often tell myself when trading that the most important candlestick is the next candlestick, I always say this to remind myself that sometimes candlesticks indicators need to be confirmed by a candlestick going the direction you want after you get the initial signal — want to confirm a reversal Doji? —then wait for the next candlestick to go the direction of the reversal, never let just a candlestick be the indication for a move, price movements lose momentum all the time, but they don't always lead to reversals, sometimes they are just catching a break before continuing.
With that said, there are combination of candlesticks that appear frequently at reversal points, the most important of them is the Engulfing pattern.
The engulfing pattern happens when a sharp rejection in price leads to a large candlestick in the opposite direction of price direction, a candlestick so big it covers (engulfs) the size of the previous candle that ends the price movement. This is a big sign that a huge force has entered the market to push the price in the opposite direction and can be a strong reversal signal.
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A typical engulfing pattern acting as price reversal zone |
The engulfing pattern, Dojis and Hammer (or shooting star) are perhaps three of the strongest reversal signals — especially on the higher time frames. But even they need to be "confirmed" by a solid candlestick going the the direction of your prediction, learn to wait for confirmation candles.
Wait till the end of the candle:
A candlestick can take different forms in it's lifetime, it can start as a Doji (sign of weakness) , then develop into a solid candle stick ( sign of strength) then end up as a hammer (sign of weakness or reversal) and depending on your patience you could be in on a bad trade from a half mature candle.
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| Would you rather have entered a sell after the large black candle 8hrs in or bought at the end of the hammer it ended up as |
It's important to learn to be patient so you can make sure you're trading with the final form of the candle on whatever time frame you're trading on. Remember, it doesn't hurt to wait for the next candlestick to confirm your suspicions, the next candle stick is often the most important candle stick.
Summary
A strengthening move : a price move will often show a increase in momentum or strength by an increase in size of the candlesticks for the move or a maintenance of the regular size of the candlesticks that started the price move.
Weakening move : a price move will often show signs of weakness by reduction in the size of the candlesticks towards the end of the move.
Doji: a sign of a halt in price movement, often seen as a stop sign before a price reversal or a comma (a breather) before it continues in it's previous direction. Doji with long rejection wicks are even bigger tell signals of reversal because they show signs of price rejection and a halt in price momentum, for this reason hammers and shooting stars are very important signals.
Typical candlestick charting as most of the other charting signals are best applied with higher timeframes than with lower time frames.
Now that you understand the language of the price chart, let me explain how price moves, click here to continue.